How To Use IBD Market Pulse To Make Money With ETFs

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How can an individual investor or a financial adviser avoid sharp sell-offs and deftly outperform the stock market? IBD's ETF Market Strategy, a new feature within IBD Leaderboard , can help.

The ETF Strategy chart, which runs every day on the ETFs page (today on A13), shows one source of its outperformance. Focus on the time period of 2007 to early 2009 in the graph. While the Nasdaq composite and the S&P 500 dived as stocks in all sectors sold off, the IBD ETF strategy, which emphasized a 100% cash position, sustained a much milder drop.

When distribution -- notable declines by the major indexes in higher volume in the relevant exchange -- is heavy, the Market Pulse in IBD's Big Picture column switches the outlook to "Market in correction." It's time to sell stocks and ETFs, avoid new buys and wait for better conditions.


If the market condition does not improve, cash becomes an even more strategic position.

The strategy is based on careful study of more than 27 U.S. bull and bear stock market cycles . It employs daily analysis of the stock market's price-and-volume action .

The best time to invest in stocks? When you confirm that the market is in an uptrend -- when as many as three of four stocks follow the market's path.

Traders who use a broad index ETF, such as SPDR S&P 500ETF Trust ( SPY ) or iShares Russell 2000Index ( IWM ), may decide to go 100% invested (within their assets allocated toward equities) when the Market Pulse outlook says "Confirmed uptrend."

Ideally, one should buy shares on or soon after the day that a follow-through occurs after a significant market decline. A follow-through is a significant gain -- typically during Day 4 to 7 of a new market rally attempt -- in higher volume by one of the key stock-market indexes.

When Outlook Changes

After a rally has been underway, selling eventually intensifies. Distribution days crop up over a short period. At some point, IBD will downgrade the outlook to "Uptrend under pressure."

When this happens, cut your ETF exposure to 50%. You're locking in gains and raising cash, yet also leaving the door open for the rally to continue. If the decline worsens, the outlook may go to "Market in correction." The right move is to sell the remaining shares and go 100% cash.

On May 4, 2011, IBD switched the current outlook from "Uptrend under pressure" to "Market in correction" after the Nasdaq fell 0.5% to 2828.23 in higher turnover. The key index also got tagged with a second straight distribution day. Leading stocks, as in the IBD 50, were sinking fast. The correction signal meant that portfolio managers should have sold their stock index ETF positions and stayed put.

From May 6 to 10, the Nasdaq rebounded three days in row but failed to take out its recent high of 2887.75. Then the market began to buckle. By mid-June, the Nasdaq was down 10.2%.

The market rebounded. The S&P 500 marked a Day 4 follow-through on June 21. But the rally lasted just two weeks. New distribution days mushroomed. On July 11, the Nasdaq fell 1.8% in higher volume, knocking the outlook from "Confirmed uptrend" to "Uptrend under pressure."

On July 27, the Nasdaq slid 2% and poked below its 50-day moving average again. IBD changed the outlook back to "Market in correction." It was time to be in cash.

By Oct. 4, the Nasdaq had fallen to 2298.88 -- a 20.3% decline that was large enough to call a bear market, albeit briefly.

Let's say you devoted $100,000 to the Market Pulse strategy on July 27. Since the Market Pulse noted that the market was in correction, you would have zero positions in any index ETF. By Oct. 4, your $100,000 would have been untouched. A flat return doesn't sound exciting; but if you had all of that money invested in the S&P 500 and ignored what the market was doing, that stake would have shrunk to $86,130, down 14%, plus any dividends paid. Ouch!



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.




This article appears in: Investing , ETFs

Referenced Stocks: SPY , IWM

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